U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
----------------------------------------------------
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
------------------------------------
COMMISSION FILE NO. 0-27649
----------------------------------
UPGRADE INTERNATIONAL CORPORATION
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
WASHINGTON 58-2441311
---------- ----------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1411 FOURTH AVENUE - SUITE 629 SEATTLE, WASHINGTON 98101
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(206) 903-3116
(ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
CHECK WHETHER THE ISSUER (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION
13 OR 15(D) OF THE EXCHANGE ACT DURING THE PAST 12 MONTHS (OR FOR SUCH SHORTER
PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN
SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
------ ------
STATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON
EQUITY AS OF THE LATEST PRACTICABLE DATE: AS OF AUGUST 15, 2002, 44,248,400
SHARES OF COMMON STOCK, $.0001 PAR VALUE WERE OUTSTANDING. (EXCLUDES
45,000,000 SHARES REGISTERED IN THE COMPANY'S NAME AND DEPOSITED INTO A CUSTODY
ACCOUNT TO SUPPORT LOAN TRANSACTION TO THE COMPANY. SEE FOOTNOTE D. SEE
FOOTNOTE C REGARDING OTHER SHARES WHICH HAVE BEEN CONTINGENTLY ISSUED. )
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE): YES [ ] NO [X]
INDEX
PART I - FINANCIAL INFORMATION
Page
Item 1. Financial Statements
------------------------------
Consolidated balance sheets at September 30, 2001 (audited) and June 30, 2002 (unaudited) . . . . 3
Consolidated statements of operations for the three and nine months ended June 30, 2001 and 2002
(unaudited) and cumulative since inception (February 5, 1997) through June 30, 2002 (unaudited) . 4
Consolidated statement of stockholders' equity (deficit) since September 30, 2001 and for the
nine months ended June 30, 2002 (unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-8
Consolidated statement of cash flows for the nine months ended June 30, 2001 and 2002 (unaudited)
And Cumulative since inception (February 5, 1997) through June 30, 2002 (unaudited) . . . . . . . 9
Notes to the Financial Statements (unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . 10-12
Item 2. Management's Discussion and Analysis or Plan of Operation. . . . . . . . . . . . . . . . 12-14
-------------------------------------------------------------------
PART II - OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
--------------------------
Item 2. Changes In Securities and Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . 14-15
--------------------------------------------------
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
--------------------------
Item 6. Exhibits and Reports on Form 8 - K . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
------- ----------------------------------
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
CONSOLIDATED BALANCE SHEETS
ASSETS
September 30, June 30,
2001 2002
------------- -------------
(unaudited)
CURRENT ASSETS
Cash and cash equivalents $ 2,551,465 $ 328,730
Restricted deposit 300,000 300,000
Subscriptions receivable 500,000 -0-
Note receivable from related party 135,243 143,021
Prepaid expenses, deposits and other 110,022 170,413
------------- -------------
Total current assets 3,596,730 942,164
PROPERTY AND EQUIPMENT - AT COST,
less accumulated depreciation and amortization 2,071,663 1,669,590
SPUTTERING MACHINE, held for sale 2,000,000 800,000
ADVANCES TO ROCKSTER GROUP 1,084,000 1,630,000
OTHER ASSETS
Intangible and deferred assets, net of accumulated
Amortization 466,256 616,846
Acquisition deposits 1,820,715 1,820,715
Deposits 194,128 194,128
------------- -------------
Total assets $ 11,233,492 $ 7,673,443
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable $ 3,853,950 $ 4,845,269
Payable to related parties 5,503,022 2,388,105
Accrued liabilities 2,972,713 3,250,361
Notes payable 1,717,231 4,395,924
Equipment purchase contract payable 2,024,748 2,024,748
Royalty and license fee payable to CardTech, Inc. 1,161,873 1,939,524
------------- -------------
Total current liabilities 17,233,537 18,843,928
CONVERTIBLE DEBENTURES, net of unamortized discount 2,004,488 372,860
LOAN PAYABLE -0- 1,210,000
MINORITY INTEREST 1,473,179 -0-
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' DEFICIT
Common stock - $.0001 par value, 250,000,000 shares authorized 24,524 40,809
Stock subscriptions 2,742,586 4,719,993
Additional paid in capital 53,947,618 80,910,480
Deferred compensation (498,559) (366,139)
Receivable from stockholders of subsidiary (266,621) (266,621)
Accumulated development stage deficit (65,427,260) (97,791,867)
------------- -------------
(9,477,712) (12,753,345)
------------- -------------
Total liabilities and stockholders' deficit $ 11,233,492 $ 7,673,443
============= =============
The accompanying notes are an integral part of these statements.
3
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Cumulative
Nine Month ended Three months ended results of
June 30, June 30, operations since
-------------------------- -------------------------- inception
2001 2002 2001 2002 (February 5, 1997)
------------ ------------ ------------ ------------ -------------------
Costs and expenses (unaudited) (unaudited) (unaudited) (unaudited) (unaudited)
Research and development $ 5,030,133 $ 3,365,431 $ 1,490,718 $ 755,962 $ 17,897,834
Purchased in-process research
& development - - - - 5,971,603
Sales and marketing 1,276,559 217,802 140,908 76,588 5,456,607
General and administrative 8,519,784 10,245,638 1,430,092 4,883,825 33,176,295
------------ ------------ ------------ ------------ -------------------
14,826,476 13,828,871 3,061,718 5,716,375 62,502,339
Other expenses (income)
Equity in losses of UltraCard - - - - 1,264,316
Interest expense and penalties 3,733,448 19,427,565 2,706,606 6,141,726 26,149,866
Loss on advances to Pathways 3,399,780 - 3,399,780 - 3,549,780
Other, net 193,290 (21,298) 106,504 (19,309) 1,747,102
------------ ------------ ------------ ------------ -------------------
7,326,518 19,406,267 6,212,890 7,322,417 32,711,064
Minority interest in losses
of subsidiaries - (870,531) - (125,000) (3,438,331)
------------ ------------ ------------ ------------ -------------------
NET LOSS $ 22,152,994 $32,364,607 $ 9,274,608 $11,713,792 $ 91,775,072
============ ============ ============ ============ ===================
LOSS PER COMMON
SHARE-BASIC AND DILUTED $ 0.64 $ 0.86 $ 0.39 $ 0.29 $ 5.55
============ ============ ============ ============ ===================
The accompanying notes are an integral part of these statements.
4
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
Since September 30, 2001 through June 30, 2002 (unaudited)
Receivable
Voting common stock Common stock subscribed Additional from
------------------- ------------------------ paid-in Deferred stockholders
Shares Amount Shares Amount capital compensation of subsidiary
---------- ------- ----------- ----------- ----------- ----------- ------------
Balances at September 30, 2001 24,523,523 $24,524 $3,892,323 $2,742,586 $53,947,618 $ (498,559) $ (266,621)
Shares issued on October 5, 2001
in connection with September
2001 conversions of debentures
at $.54 to $1.30 per share 971,725 972 (971,843) (636,625) 635,653 - -
Contribution from minority
interest - - - - 727,648 - -
Shares issued on October 11, 2001
in lieu of loan interest and
penalties at $1.48 per share 52,434 52 - - 77,550 - -
Shares issued on October 20 and
21, 2001 at $1.58 per share in
lieu of loan interest and
penalties 151,671 152 - - 239,488 - -
Shares issued on November 7, 2001
in connection with October 10,
11 and 12, 2001 conversion of
debentures at $.535 per share 3,116,633 3,117 - - 1,684,299 - -
Shares issued on November 7, 2001
in connection with October 12,
2001 conversion of convertible
debentures $.543 per share 979,095 979 - - 595,830 - -
Shares issued on November 7, 200
1 at $1.48 per share in lieu of
penalties in connection with
October 11, 2001 conversion
of convertible debentures 51,743 352 - - 520,228 - -
Shares issued on November 7, 2001
at $1.41 per share in lieu of
penalties in connection with
October 12, 2001 conversion
of convertible debentures 445,540 445 - - 627,766 - -
Shares issued on November 7, 2001
at $1.71 per share in lieu of
penalties in connection with
October 10, 2001 conversion
of convertible debentures 413,864 414 - - 707,293 - -
Shares issued on November 9, 2001
(previously subscribed to in
September 2001 at $.50, $.70,
and $1.00 per share) 2,800,000 2,800 (2,800,000) (1,820,000) 1,817,200 - -
Shares issued on November 9, 2001
in lieu of finder's fees on
previous placements 750,000 750 - - (750) - -
Shares issued on November 9, 2001
at a $1.00 in lieu of settlement
of payables to stockholders
and cash, net of fees 905,205 905 - - 901,700 - -
Shares issued on November 9, 2001
at a $1.41 lieu of fees in
connection with a private
placement 25,000 25 - - (25) - -
Shares issued on November 9, 2001
(previously subscribed to in
July 2001 at $2.00 per share) 25,000 25 (25,000) (50,000) 49,975 - -
Shares issued on November 9, 2001
in connection with October 15,
2001 conversion of debentures
at $1.25 and $1.50 per share 776,919 777 - - 1,010,433 - -
Shares subscribed to on
November 11, 2001 at $1.41 per
share in lieu of interest and
penalties - - 56,970 80,328 - - -
Shares subscribed to on November
19 and 21, 2001 at $1.15 per
share in lieu of interest and
penalties - - 48,532 55,812 - - -
Shares subscribed to on December
1 and 2, 2001 at $1.34 per
share in lieu of interest
and penalties - - 56,419 75,601 - - -
Shares subscribed to on
December 9, 2001 at $1.09 per
share in lieu of interest and
penalties - - 32,593 35,526 - - -
Shares subscribed to on December
12, 2001 at $1.05 per share in
lieu of interest and penalties - - 22,070 23,102 - - -
Shares subscribed to on December
19, 2001 at $0.88 per share in
lieu of interest and penalties - - 47,124 41,469 - - -
Shares subscribed to on December
22 and 29, 2001 at $0.80 per
share in lieu of interest and
penalties - - 33,914 27,131 - - -
Shares subscribed to on December
31, 2001 at $0.78 per share in
lieu of interest and penalties - - 26,253 20,477 - - -
Shares issued on November 26, 2001
in lieu of payment of legal fees 100,000 100 - - 99,900 - -
5
Accumulated
development
stage deficit Total
------------- ------------
Balances at September 30, 2001 $(65,427,260) $(9,477,712)
Shares issued on October 5, 2001
in connection with September
2001 conversions of debentures
at $.54 to $1.30 per share - -
Contribution from minority
interest - 727,648
Shares issued on October 11, 2001
in lieu of loan interest and
penalties at $1.48 per share - 77,602
Shares issued on October 20 and 21,
2001 at $1.58 per share in lieu
of loan interest and penalties - 239,640
Shares issued on November 7, 2001
in connection with October 10,
11 and 12, 2001 conversion of
debentures at $.535 per share - 1,687,416
Shares issued on November 7, 2001
in connection with October 12,
2001 conversion of convertible
debentures $.543 per share - 596,809
Shares issued on November 7, 200
1 at $1.48 per share in lieu of
penalties in connection with
October 11, 2001 conversion
of convertible debentures - 520,580
Shares issued on November 7, 2001
at $1.41 per share in lieu of
penalties in connection with
October 12, 2001 conversion
of convertible debentures - 628,211
Shares issued on November 7, 2001
at $1.71 per share in lieu of
penalties in connection with
October 10, 2001 conversion
of convertible debentures - 707,707
Shares issued on November 9, 2001
(previously subscribed to in
September 2001 at $.50, $.70,
and $1.00 per share) - -
Shares issued on November 9, 2001
in lieu of finder's fees on
previous placements - -
Shares issued on November 9, 2001
at a $1.00 in lieu of settlement
of payables to stockholders
and cash, net of fees - 902,605
Shares issued on November 9, 2001
at $1.41 lieu of fees in connection
with a private placement - -
Shares issued on November 9, 2001
(previously subscribed to in
July 2001 at $2.00 per share) - -
Shares issued on November 9, 2001
in connection with October 15,
2001 conversion of debentures
at $1.25 and $1.50 per share - 1,011,210
Shares subscribed to on November
11, 2001 at $1.41 per share in
lieu of interest and penalties - 80,328
Shares subscribed to on November
19 and 21, 2001 at $1.15 per
share in lieu of interest and
penalties - 55,812
Shares subscribed to on December
1 and 2, 2001 at $1.34 per share
in lieu of interest and penalties - 75,601
Shares subscribed to on December
9, 2001 at $1.09 per share in
lieu of interest and penalties - 35,526
Shares subscribed to on December
12, 2001 at $1.05 per share in
lieu of interest and penalties - 23,102
Shares subscribed to on December
19, 2001 at $0.88 per share in
lieu of interest and penalties - 41,469
Shares subscribed to on December
22 and 29, 2001 at $0.80 per
share in lieu of interest and
penalties - 27,131
Shares subscribed to on December
31, 2001 at $0.78 per share in
lieu of interest and penalties - 20,477
Shares issued on November 26, 2001
in lieu of payment of legal fees - 100,000
6
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)- Continued
Since September 30, 2001 through June 30, 2002 (unaudited)
Receivable
Voting common stock Common stock subscribed Additional from
------------------- ------------------------ paid-in Deferred stockholders
Shares Amount Shares Amount capital compensation of subsidiary
--------- ------- ----------- ----------- ---------- ----------- ------------
Shares issued on November 26, 2001
in connection with a private
placement at $1.36 per share 18,437 18 - - 24,982 - -
Shares issued on November 26,
2001 in connection with a
private placement and
satisfaction of liabilities at
$1.10, net of transactions
costs 562,171 562 - - 443,184 - -
Shares issued on December 7, 2001
at $1.09 per share in lie of
fees and penalties in connection
with October 10 through 12, 2001
conversion of convertible
debentures 948,843 949 - - 972,536 - -
Warrants granted in lieu of
interest and penalties - - - - 1,956,457 - -
Shares subscribed to and warrants
issued in lieu of additional
interest on convertible
debentures - - 434,220 594,881 580,035 - -
Shares subscribed at $.80 through
$1.37 per share in connection
with November and December 2001
promissory notes - - 202,167 182,265 - - -
Warrants issued in connection with
November through December 2001
promissory notes - - - - 217,898 - -
Adjustment due to modification
of warrants - - - - 32,922 - -
Adjustment due to added conversion
feature on notes payable - - - - 200,000 - -
Allocation to beneficial
conversion feature - - - - 150,000 - -
Amortization of deferred
compensation for the three
months ended December 31, 2001 - - - - - 49,326 -
Shares issued on January 13, 2002
pursuant to penalty and interest
adjustments to convertible debenture
at prices of $1.02 & $1.03 59,953 60 - - 50,103 - -
Shares issued February 4, 2002 as
loan inducement fees for shares
previously subscribed in November
& December 2001 354,300 354 (354,300) (119,024) 118,670 - -
Shares issued February 4, 2002 at
prices from $1.03 to $1.08 pursuant
to loan inducement fees for loans
provided to the Company in January
2002 35,063 35 - - 131,380 - -
Shares issued February 4, 2002 as
payment of penalties and interest
on loan agreements 345,683 346 (323,875) (329,036) 412,072 - -
Shares issued February 4, 2002 as
payment of penalty and interest
on loan agreements incurred in
January 2002 299,993 300 - - 315,446 - -
Shares and warrants issued
February 4,2002 as payment
of penalties and interest on
loan agreements incurred in
February 2002 34,231 34 - - 48,574 - -
Shares and warrants
issued on February 26, 2002
in settlement of debts 1,000,000 1,000 - - 1,465,000 - -
Shares issued March 4, 2002 for
shares previously subscribed
Pursuant to private placements
at $2.00 per share 12,000 12 (12,000) (24,000) 23,988 - -
Shares subscribed in connection
with February penalties and
interest on loan agreements - - - 350,204 526,255 - -
Adjustment to shares subscribed
and warrants issued in March
in connection with notes payable - - - 29,300 484,846 - -
Warrants issued during the three
months ended March 31, 2002 as
penalties and interest on
promissory notes - - - - 2,923,527 - -
Shares and warrants granted in
connection with March 2002 notes - - 350,000 181,275 166,245 - -
Shares and warrants granted in March
2002 at $1.01 to $1.08 per share
pursuant to loan inducement fees for
loan provided in March 2002 - - 144,375 155,925 417,244 - -
Amortization of deferred compensation
for the three months ended
March 31, 2002 - - - - - 41,547 -
7
Accumulated
development
stage deficit Total
-------------- -------------
Shares issued on November 26, 2001
in connection with a private
placement at $1.36 per share - 25,000
Shares issued on November 26,
2001 in connection with a
private placement and
satisfaction of liabilities at
$1.10 per share, net of transaction
costs - 443,746
Shares issued on December 7, 2001
at $1.09 per share in lieu of
fees and penalties in connection
with October 10 through 12, 2001
conversion of convertible
debentures - 973,485
Warrants granted in lieu of
interest and penalties - 1,956,457
Shares subscribed to and warrants
issued in lieu of additional
interest on convertible
debentures - 1,174,916
Shares subscribed at $.80 through
1.37 per share in connection
with November and December 2001
promissory notes - 182,265
Warrants issued in connection with
November through December 2001
promissory notes - 217,898
Adjustment due to modification
of warrants - 32,922
Adjustment due to added conversion
feature on notes payable - 200,000
Allocation to beneficial
conversion feature - 150,000
Amortization of deferred
compensation for the three
months ended December 31, 2001 - 49,326
Shares issued on January 13, 2002
pursuant to penalty and interest
adjustments to convertible debenture
at prices of $1.02 & $1.03 - 50,163
Shares issued February 4, 2002 as
loan inducement fees for shares
previously subscribed in November &
December 2001 - -
Shares issued February 4, 2002 at
prices from $1.03 to $1.08 pursuant to
loan inducement fees for loans provided
to the Company in January 2002 - 131,415
Shares issued February 4, 2002 as
payment of penalties and interest on
loan agreements - 83,382
Shares issued February 4, 2002 as
payment of penalty and interest on
loan agreements incurred in January
2002 - 315,746
Shares and warrants issued
February 4,2002 as
payment of penalties and interest
on loan agreements incurred in
February 2002 - 48,608
Shares and warrants issued February 26, 2002
in settlement of debts - 1,466,000
Shares issued March 4, 2002 for
shares previously subscribed
Pursuant to private placements
at $2.00 per share - -
Shares subscribed in connection with
February penalties and interest on loan
agreements - 526,255
Adjustment to shares subscribed and
warrants issued in March
in connection with notes payable - 514,146
Warrants issued during the three
months ended March 31, 2002 as
penalties and interest on promissory
notes - 2,923,527
Shares and warrants granted in
Connection with March 2002 notes - 347,520
Shares and warrants granted in March
2002 at $1.01 to $1.08 per share
pursuant to loan inducement fees for
loan provided in March 2002 - 573,169
Amortization of deferred compensation for
the three months ended March 31, 2002 - 41,547
8
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)- Continued
Since September 30, 2001 through June 30, 2002 (unaudited)
Receivable
Voting common stock Common stock subscribed Additional from
------------------- ------------------------ paid-in Deferred stockholders
Shares Amount Shares Amount capital compensation of subsidiary
---------- ------- ----------- ------------ ---------- --------------- -------------
Warrants granted to consultants
in settlement of fees, providing
the warrant holder the right to
acquire up to 1,730,000 shares at
price ranging from $1.00 to $2.50 - - - - 512,114 - -
Shares and warrants granted in
April 2002 as a finders fee on
loans extended in March 2002 55,000 55 61,875 66,825 273,433 - -
Shares and warrants issued in
April 2002 at prices from $0.85
To $1.08 per share pursuant to
loan inducements fees 212,500 213 150,000 45,000 142,674 - -
Shares and warrants granted during
April 2002 as penalties and interest
on promissory notes - - 771,173 668,610 1,121,715 - -
Shares issued April 5, 2002 as loan
inducement fees for shares
subscribed in March, 2002 350,000 350 (350,000) (181,275) 180,925 - -
Shares subscribed on April 25,2002
As settlement of debts of subsidiary
company at $1.007 per share. - - 400,000 402,875 - - -
Common Shares and warrants issued on
April 5,2002 at a price of $1.00 per
share in connection with private
placement 100,000 100 - - 99,900 - -
Shares issued in April as a finders
fee on September 2001 share issuance 25,000 25 - - (25) - -
Shares and warrants issued on April
10,2002 paid as a finders fee on
April notes 6,875 7 - - 3,383 - -
Shares and warrants granted on April
10,2002 paid as a finder fee on April
notes - - 73,219 56,109 144,608 - -
Warrants issued on April 30,2002 in
connection with convertible debenture
providing to the holders the right
acquire 362,200 shares at the price
of $0.75 for five years from the
date of issuance - - - - 254,967 - -
Warrants issued on April 30,2002
to officer of the Company in connection
with $775,000 convertible debenture
agreement The warrants provide to the
holer the right to acquire 1,200,000
at a price of $.75 per share for a
period of five years - - - - 896,166 - -
Shares and warrants granted in May 2002
at $0.80 per share pursuant to loan
inducements fees - - 250,000 27,772 25,780 - -
Shares and warrants granted during May
2002 as penalties and interest on
promissory note - - 897,298 587,535 1,203,595 - -
Shares and warrants granted on May 2002
paid as finder fees - - 110,000 71,445 183,177 - -
Shares and warrants granted in June 2002
at the prices from $0.38 to $$ 0.44
per shares pursuant to loan inducement
fees from loans provided in June 2002 - - 50,000 17,016 60,012 - -
shares and warrants granted during June
2002 as penalties and interest on
promissory notes - - 1,166,073 514,833 1,034,524 - -
Shares subscribed at $0.50 per share
on May 29,2002 as partial payment to
related party creditor and to secure
deferral of amounts due to creditor
of subsidiary company - - 1,300,000 650,000 - - -
Amortization of deferred
compensation for the three months
ended June 30, 2002 - - - - - 41,547 -
Net loss for the nine months
ended June 30, 2002 - - - - - - -
---------------------------- ---------- ------- ----------- ------------ ------------ -------------- ------------
Balances at June 30, 2002 40,808,401 $40,809 6,089,784 $ 4,719,993 $80,910,480 $ (366,139) $ (266,621)
========== ======= =========== ============ ============ ============== ============
9
Accumulated
development
stage deficit Total
------------- -------------
Warrants granted to consultants
in settlement of fees, providing
the warrant holder the right to
acquire up to 1,730,000 shares at
price ranging from $1.00 to $2.50 - 512,114
Shares and warrants granted in
April 2002 as a finders fee on
loans extended in March 2002 - 340,313
Shares and warrants issued in
April 2002 at prices from $0.85
to$1.08 per share pursuant to
loan inducements fees - 187,887
Shares and warrants granted during
April 2002 as penalties and interest
on promissory notes - 1,790,325
Shares issued April 5, 2002 as loan
inducement fees for shares
subscribed in March, 2002 - -
Shares subscribed on April 25,2002
As settlement of debts of subsidiary
company at $1.007 per share. - 402,875
Common Shares and warrants issued on
April 5,2002 at a price of $1.00 per
share in connection with private
placement - 100,000
Shares issued in April as a finders
fee on September 2001 share issuance - -
Shares and warrants issued on April
10,2002 paid as a finders fee on
April notes - 200,724
Warrants issued on April 30,2002 in
connection with convertible debenture
providing to the holders the right
acquire 362,200 shares at the price
of $0.75 for five years from the
date of issuance - 254,967
Warrants issued on April 30,2002
to officer of the Company in connection
with $775,000 convertible debenture
agreement The warrants provide to the
holer the right to acquire 1,200,000
at a price of $.75 per share for a
period of five years - 896,166
Shares and warrants granted in May 2002
at $0.80 per share pursuant to loan
inducements fees - 53,552
Shares and warrants granted during May
2002 as penalties and interest on
promissory note - 1,791,130
Shares and warrants granted on May 2002
paid as finder fees - 254,622
Shares and warrants granted in June 2002
at the prices from $0.38 to $$ 0.44
per shares pursuant to loan inducement
fees from loans provided in June 2002 - 77,028
Shares and warrants granted during June
2002 as penalties and interest on
promissory notes - 1,549,357
Shares subscribed at $0.50 per share
on May 29,2002 as partial payment to
a related party creditor to secure
deferral of amounts due to creditor of
subsidiary company - 650,000
Amortization of deferred
compensation for the three months
ended June 30, 2002 - 41,547
Net loss for the nine months
ended June 30, 2002 (32,364,607) (32,364,607)
---------------------------- ------------- -------------
Balances at June 30, 2002 $(97,791,867) $(12,753,345)
============= =============
The accompanying notes are an integral part of this statement.
10
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine months ended June 30, Cumulative
--------------------------------- since inception
Increase (Decrease) in Cash and Cash Equivalents 2001 2002 (February 5, 1997)
------------- ------------------ ------------------
Cash flows from operating activities:
Net loss $(22,152,994) $ (32,364,607) $ (91,775,072)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 531,544 278,534 1,469,144
Amortization of beneficial conversion feature
and debt discount 1,884,151 3,797,826 7,596,019
Amortization of loan costs - 651,849 651,849
Write off of leasehold improvements - 210,805 210,805
Modification of loan agreements - 232,922 232,922
Equity securities issued in lieu of interest
and penalties on debt - 16,175,500 18,854,246
Employee stock options issued below fair value - 132,420 1,396,424
Adjustment to receivables from subsidiary's
stockholders - - 133,379
Write off of uncollectible advances 3,399,780 - 3,549,780
Write off due to impairment of machine
held for sale - 1,200,000 2,254,125
Write off of option cost - - 76,250
Loss on sale of property and equipment 29,904 - 26,021
Common stock subscribed for financing fees 416,529 - -
Equity in loss of UltraCard - - 1,264,316
Purchased in-process research & development - - 5,971,603
Warrants and options issued for services 1,903,685 512,114 5,646,289
Warrants issued for financing fees 1,418,433
Shares issued for services - - 488,650
Expenses incurred through loan assumption - - 470,005
Stock of subsidiary issued in exchange for
contribution of intellectual property
charged to expense - - 125,000
Minority interest - (870,531) (3,438,331)
Changes in assets and liabilities:
Prepaid expenses, deposits and other (274,976) (63,012) 941,090
Accounts payable and accrued liabilities 4,400,180 4,257,269 12,565,850
---------------- ------------------ ------------------
Net cash used in operating activities (8,443,764) (5,848,911) (31,289,636)
Cash flows from investing activities
Advances to The Pathways Group, Inc. (1,498,955) - (3,533,955)
Advances to Rockster, Inc. (950,000) (546,000) (1,630,000)
Advances to eCourier Corps - - (130,000)
Payments on equipment under construction - - (1,200,000)
Acquisition of property and equipment, net (587,063) (56,777) (1,755,544)
Acquisition of Centurion Technologies, Inc.,
net of cash acquired - - (1,000,000)
Acquisition of UltraCard, Inc., net of
cash acquired - (379,164) (5,950,269)
Acquisition of equity interest in EforNet Corp.
from a minority shareholder - - (200,000)
Additions to note receivable from related party (130,000)
Acquisition deposit (15,000) - (62,500)
Additions to intangible assets (66,470) (25,463) (220,650)
---------------- ------------------ ------------------
Net cash used in investing activities (3,247,488) (1,007,404) (15,682,918)
Cash flows from financing activities
Proceeds from sale of common stock and
stock subscriptions 6,255,614 1,071,746 36,801,964
Borrowings, net of loan costs 5,945,251 3,600,285 13,752,905
Principal payments on borrowings (1,361,370) (38,451) (3,721,371)
Purchase of collateral on subsidiary's LOC - - (805,687)
Release of restricted cash 505,687 - 505,687
Proceeds from exercise of options & warrants 55,000 - 767,786
----------------- ------------------ ------------------
Net cash provided by financing activities 11,400,182 4,633,580 47,301,284
----------------- ------------------ ------------------
Net increase(decrease)cash & cash equivalents (291,070) (2,222,735) 328,730
Cash & cash equivalents beginning of period 398,989 2,551,465 -
----------------- ------------------- -------------------
Cash &cash equivalents end the period $ 107,919 $ 328,730 $ 328,730
================= =================== ===================
The accompanying notes are an integral part of these statements.
11
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001 and 2002
NOTE A - FINANCIAL STATEMENTS
The unaudited consolidated financial statements of the Company and its
subsidiaries have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles of the United States of
America (GAAP) have been condensed or omitted pursuant to such rules and
regulations. The results of operations for interim periods are not necessarily
indicative of the results to be expected for the entire fiscal year ending
September 30, 2002. This form 10-QSB should be read in conjunction with the form
10-KSB that includes audited consolidated financial statements for the year
ended September 30, 2000 and 2001, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for the years then
ended and since inception (February 5, 1997), and the form 10-QSB for the
quarters ended March 31, 2001 and 2002.
NOTE B - BASIS OF PRESENTATION
The Company consolidates all companies in which it has a controlling financial
interest. This generally occurs when the Company owns more than 50% of the
outstanding voting shares of the company. The Company also consolidates 50%
owned companies in which it has voting control through agreements with other
shareholders. Investments in Companies where the Company has significant
influence through ownership of 20% to 50% of the investors voting shares or
contractual arrangements are accounted for by the equity method.
The balance sheet as of September 30, 2001 and June 30, 2002, reflects the
consolidated financial position of the Company and its subsidiaries
(Subsidiaries) as follows: UltraCard, Inc. (UltraCard); cQue Corporation
(formerly Centurion Technologies, Inc.); CTI Acquisition Corporation (CTI);
Global CyberSystems, Inc. (Global); EforNet Corporation (EforNet); Global
CyberSystems SA. (GCSA), Global CyberSystems PLC (GCPLC) and UltraCard China
Inc. The statements of operations for the three and nine months ended June 30,
2001 and 2002 and for the period from inception (February 5, 1997) and the
statements of cash flows for the nine months ended June 30, 2001 and 2002 and
for the period from inception (February 5, 1997) reflect the consolidated
results of operations and cash flows of the Company and the results of the
subsidiaries beginning on the dates the Company acquired control. All
significant inter-company balances and transactions have been eliminated in
consolidation. Minority interest represents the minority stockholders'
proportionate share in the equity of the Company's consolidated Subsidiaries.
The losses incurred by a subsidiary are allocated on a proportionate basis to
minority interest until the carrying amount of minority interest is eliminated.
Further losses are then included in the net loss of the Company.
NOTE C - LOSS PER COMMON SHARE AND SHARES OUTSTANDING
Basic loss per share is computed by dividing the net loss by the weighted
average number of common shares outstanding during the period. The weighted
average number of shares outstanding for the nine and three months ended June
30, 2002 was 37,833,319 and 40,788,805, respectively and 21,829,283 and
18,323,267 for the nine and three months ended June 30, 2001, respectively, and
16,533,687 since inception (February 5, 1997) through June 30, 2002. Diluted
loss per share for all periods presented equaled basic loss per share due to
antidilutive effect of the potentially dilutive securities.
In addition at June 30, 2002, 48,365,000 shares of the Company's common stock
were not included in the shares issued and outstanding on the consolidated
statement of stockholders' deficit or loss per share computations. The excluded
shares were as follows:
- Shares issued in lieu of finders' fees in connection with future findings
1,365,000 (with 1,000,000 shares outstanding at September 30, 2001 and
365,000 shares issued during the quarter ended December 31, 2001).
- Shares held by the Company in connection with loan assumptions - 2,000,000
shares. In October 2001, the Company issued 2,000,000 to replace the
2,000,000 shares originally transferred by the Company's president to an
unrelated third party as a collateral for $1,210,000 loan payable. In
October 2001, the Company assumed the president's liability on the loan and
issued 2,000,0000 shares. The original collateral shares were then
transferred into the Company's name by the president.
- Contingently issued, 45,000,0000 restricted shares issued to an
institutional syndicator, held as collateral for a future financing as
described in note D. The shares were cancelled and are being returned to
the Company subsequent to June 30, 2002.
12
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001 and 2002
NOTE D - MANAGEMENT PLANS
The Company is a development stage enterprise as defined under Statement of
Financial Accounting Standards No. 7. The Company is devoting its present
efforts into establishing a new business in the information technology industry
and, is currently in the process of identifying markets and establishing
applications for its technologies. Accordingly, no operating revenues have been
generated. The Company's operations to date have consumed substantial and
increasing amounts of cash. The Company's negative cash flow from operations is
expected to continue in the foreseeable future. The development of the Company's
technology and potential products will continue to require a commitment of
substantial funds. The Company expects that its existing and expected financings
will be adequate to satisfy the requirements of its current and planned
operations until the end of the fiscal year 2002. However, the rate at which the
Company expends its resources is variable, may be accelerated, and will depend
on many factors. The Company will need to raise substantial additional capital
to fund its operations and may seek such additional funding through public or
private equity, debt financing or through strategic relationships with
development partners. There can be no assurance that such additional funding
will be available on acceptable terms, if at all. The Company's continued
existence as a going concern is ultimately dependent upon its ability to secure
additional funding for completing and marketing its technology and the success
of its future operations.
The following summarizes the debt and equity transactions completed by the
Company during the three months ended June 30, 2002:
In April 2002, the Company borrowed $575,000 from existing debt holders pursuant
to 30-day note agreements. Interest and penalties are required under the terms
of the notes payable every 30 days comprised of 10%-12.5% interest, 12.5% of the
original loan amount payable in common stock and up to 30% of the original loan
amount in warrants at an exercise price of the lowest average closing bid price
for a period 120 days prior to the date of the loan maturity but not more than
$0.25 to $0.80. In connection with these loans the Company issued 362,500 shares
of common stock, and warrants entitling the holder to purchase 362,500 shares of
common stock at $.80 to $1.00 per share. The warrants are exercisable
immediately and expire five years from the date of grant. As a finders fee on
these agreements the Company issued notes in the amount of $30,250, 80,094
shares and 193,532 warrants to acquire common stock at an exercise price ranging
from market to $0.80 per share.
On April 30, 2002 the Company converted previously outstanding unsecured
shareholders' advances in the amount of $290,823 pursuant to the terms of two
convertible debentures. The debentures bear interest at a rate of 10% per annum,
are immediately convertible into common stock at $0.75 per share, and mature on
December 31, 2002. In addition, the Company issued 290,823 warrants to acquire
common stock of the Company at a price of $0.75 per share expiring five years
from the date of issuance.
In April 2002, the Company settled debt to a creditor of its subsidiary in the
amount of $402,875 through the issuance of four hundred thousand shares in the
common stock of the Company.
On April 5, 2002 the Company received proceeds of $100,000 pursuant to the terms
of a private placement of common stock of the Company at a price of $1.00 per
share. In conjunction with the offering the Company issued 100,000 warrants at a
exercise price of $1.00.
In April 2002 the Company issued warrants to acquire 1,730,000 shares in the
Common stock of the Company to a group of consultants in settlement of amounts
due those consultants. Of those warrants, 1,250,000 vest equally over a 12 month
period. The warrants have exercise prices ranging from $1.00 to $2.50, are
exercisable immediately and have a five year term. As of June 30, 2002, 395,831
warrants were vested and earned in connection with all warrants vested and
earned as of June 30, 2002, the Company recognized $512,114 in consulting fees.
In May 2002, the Company borrowed $125,000 from existing debt holders pursuant
to 30-day note agreements. Interest and penalties are required under the terms
of the notes payable every 30 days comprised of 12.5% interest, 12.5% of the
original loan amount payable in common stock and up to 30% of the original loan
amount in warrants at an exercise price of market but not more than $0.25 per
share. In connection with these loans the Company issued 250,000 shares and
250,000 warrants to acquire shares of the Company at a price of $0.75 per share.
The warrants have a five year term. In addition, the Company paid a financing
fee comprised of a note payable in the amount of $13,750, 110,000 shares in the
capital stock of the Company and 275,000 warrants to acquire common shares of
the Company at a price of $0.25. The warrants are exercisable immediately and
expire five years from the date of grant.
On May 29, 2002, the Company entered into a release and settlement agreement
with CardTech, Inc., providing for the settlement of $650,000 due and owing to
CardTech by UltraCard. The amount of $650,000 was settled by the issuance of
1,300,000 shares in the common stock of Upgrade International Corp.
In June 2002, the Company received $90,000 from a group of private investors
pursuant to the terms of certain promissory notes agreements. The promissory
notes bear interest at the rate of 10%, regardless of the term of the note and
mature in 60 days from the date of issuance. The company also granted 180,000
warrants in aggregate to the note holders to acquire common stock of the Company
at a strike price of $0.25 per share. The warrants are exercisable immediately
and expire five years from the date of grant. Additional warrant coverage is
made available in the amount of 1,000 warrants per day at a strike price of
$0.25 per share, on two notes each in the amount of $25,000 if the loans are
unpaid by maturity.
In June 2002, the Company received from an individual private investor proceeds
of $250,000 pursuant to a promissory note agreement. The promissory notes bears
interest at the rate of 10% per annum and matures 60 days from the date of
issuance and had 50,000 of detachable warrants. In addition, the Company granted
50,000 shares of the common stock of the Company and an additional 50,000 shares
in the common stock of UltraCard, and 50,000 warrants with a exercise price of
$0.25 per share with a five-year term.
During the third quarter of 2002, the Company borrowed $100,000 from an officer
of the Company, which brought the total amount advanced by that officer to
$775,000. On April 30, 2002, that balance was rolled into a convertible
debenture, bearing interest at a rate of 10% per annum and convertible into the
common stock of the Company at $0.75 per share. The convertible debenture has a
maturity date of December 31, 2002, and had 750,000 detachable warrants issued
as part of the debt transaction, to acquire common stock at a price of $0.75 per
share with a cashless exercise provision and a five-year term. As an inducement
fee, the Company issued 450,000 warrants that bear the same terms and warrants
issued with debt.
In February 2002, the Company entered into a debt financing agreement with an
institutional syndicator to obtain up to $15 million in working capital for
Upgrade and its Subsidiaries. The debt instrument planned for is a
seven-year term with the principal due at maturity, and interest payable
quarterly commencing in year three of the financing. The loan is to be secured
by the issuance of 40 million shares of Company Stock, which have been issued
under Rule 144A along with 5 million restricted common shares issued under Rule
506D . The shares issued under Rule 144A carries a different CUSIP number from
the Company's Common Stock. These shares are restricted, and can only be traded
among qualified institutional investors. Upon repayment of the credit facility,
the shares are to be returned to the Company. Contained in the agreement is the
stipulation that the voting rights of the 45 million shares by way of proxy will
be voted in proportion with the existing shareholder base. This transaction
never funded, and the Company has requested the return of the stock and
cancelled the shares subsequent to the end of the quarter.
The Company is actively pursuing new investment into the Company, including a
significant bond transaction. Future financings may take the form of equity,
convertible debentures and other types of debt instruments.
13
Upgrade International Corporation and Subsidiaries
(A development stage enterprise)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001 and 2002
NOTE E - SPUTTERING MACHINE
On February 28, 2000, a subsidiary of the Company entered into an agreement with
an unrelated company (the Supplier) to build a sputtering machine originally for
use in its research and development activities. During the year ended September
30, 2000, the subsidiary paid $1,200,000 to the Supplier and recorded a
liability for the amounts billed but unpaid as of September 30, 2000 equaling
$2,307,025. The liability also included applicable sales tax, rent payments
allocation, and amounts due under a development contract with the Supplier
requiring $50,000 monthly payments, which expired prior to September 30, 2000
but was then orally extended to January 12, 2001. During the year 2001, the
Company's management changed its intent of the use of the machine for internal
purposes which resulted in the Supplier's removing the tax liability of
$247,500. As of September 30, 2001 and June 30, 2002 , amounts billed but the
unpaid relating to the machine, rent allocations, and the development contract
totaled $2,024,748.
During fiscal year 2001, management decided to subcontract some of the
manufacturing for the UltraCard technology products. The Company believes the
most likely disposition of the sputtering machine will be to sell it to the
manufacturer of the component that the machine is designed for. As result of
this decision, the sputtering machine is classified as held for sale.
Accordingly, the Company has written down its carrying amount to the estimated
fair value of $2,000,000 at September 30, 2001. Fair value was determined based
on management's estimate of the asset's method and likelihood of disposition.
The Company recognized a $1,054,125 impairment loss during the year ended
September 30, 2001.
Because of the special purpose nature of this piece of equipment, and in the
event that the machine is not used for its intend and designed use, the Company
decided to write down the value of the equipment to its estimated liquidiated
value of $800,000. As a result the Company recorded a $1,200,000 impairment
loss during the quarter ended June 30, 2002.
NOTE F - COMMITMENTS AND CONTINGENCIES
The Company is in default on its payments on its ten-year lease for office space
located in Los Angeles, California. Rockster, Inc. had been occupying this
facility, but vacated it in April 2002. Subsequent to March 31, 2002, the
Company began negotiations with the landlord to terminate the lease and settle
the amounts owing. These negotiations are expected to be completed during the
current fiscal year. The carrying amount of the related leasehold improvements
were approximately $211,000, which were written off during the quarter ended
March 31, 2002. The Company granted the landlord 250,000 warrants on May 5, 2002
to purchase common stock at $.50 per share, which are refundable upon successful
conclusion of the negotiations, which is planned to be completed during
September 2002.
The Company remains in default on its payments under various agreements to
purchase 826,482 shares of UltraCard, Inc. common stock and 10,000 shares of
CardTech, Inc. (CardTech) common stock. Cash flow permitting, the Company plans
to become current on its obligations under these agreements during the quarter
ending September 30, 2002. If the Company is unable to do this, it may have to
write-off as much as $1,820,715 in acquisition deposits recorded at June 30,
2002.
During the quarter, the Company and Cardtech agreed to defer all licensing and
royalty payments currently due. Under the terms of the amendment, CardTech has
agreed to defer approximately $2.25 million, and any additional monies due, by
way of minimum royalty payments, until the sooner of (i) the commercialization
of the intellectual property (revenues from product sales of same) that is the
subject of the License, or (ii) the completion of an initial public offering
with net proceeds to UltraCard of not less than Fifty Million dollars
($50,000,000).
In addition, CardTech has agreed to exchange the required $650,000.00 payment
under an exchange of debt-for-equity agreement with Upgrade International, for
1.3 million shares of Upgrade International Corporation common stock. Among the
provisions of this agreement is the right for CardTech to put back the shares
for a one year period. As of June 30, 2002, these shares are classified as
common shares subscribed on the Consolidated Statement of Stockholders' Equity
(Deficit).
NOTE G - SUBSEQUENT EVENTS
During July and August 2002, the Company borrowed in the aggregate $70,000 from
existing shareholders pursuant to certain 60-day note agreements. Interest under
the terms of the notes payable upon maturity varied between 10% - 12%. In
addition, as a cost of the financing, the Company granted the noteholders
warrants to purchase in the aggregate 190,000 shares of common stock at a price
of $0.25 per share. The warrants are exercisable immediately and expire five
years from the date of grant.
During July 2002, the Company received advances from an existing shareholder in
the amount of $45,000.
During August 2002, the Company received an advance totaling $138,720.
ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain statements contained in this Quarterly Report on Form 10-QSB, including,
without limitation, statements containing the words "believes, " anticipates,"
"estimates," "expects," and words of similar import, constitute "forward looking
statements." You should not place undue reliance on these forward- looking
statements. Our actual results could differ materially from those anticipated in
these forward- looking statements for many reasons, including the risks faced by
us described in this Quarterly Report and in other documents we file with the
Securities and Exchange Commission.
BUSINESS OPPORTUNITIES & THE COMMERCIALIZATION PROCESS
Upgrade and its companies continues to focus on two significant initiatives.
One is closing a significant financing which will provide adequate working
capital to fund the final phase of commercializing its products. Upgrade
management is spending a significant time and effort in this regard. The
Company has retained an investment advisor who is directing an effort to
consummate a significant bond transaction which, if successful, will provide the
Company with adequate working capital to complete commercialization. The
necessary documentation to bring this transaction is currently being drafted and
marketing is expected to take place in late August and September.
Second are the steps necessary to complete the commercialization process
include: final design and production of the cardbody; (the proprietary hard
drive like media, "shim", which is housed inside the cardbody, which meets the
international standards for card size, thickness and flexibility), final design
of the first read-write device and the operating and application software which
resides on the "shim". The software includes the operating system and specific
application software that will provide functionality to the UltraCard.
The Company intends to align with others to commercialize the UltraCard
technology. This has taken form in the case of contracted manufacturing or
consulting services, i.e. Pemstar, Infineon, and Komag, or potential
partnerships / joint ventures. Pemstar, Infineon and Komag have made
significant contributions to the commercialization of the UltraCard technology.
Without their individual efforts, the accomplishments to date would have taken
Longer. These types of relationships have proven successful for the Company, and
management believes they along with other potential partners will continue to
provide the necessary resources to achieve commerialization of the UltraCard
technology.
Management believes that the UltraCard technology can be commercialized much
sooner by using contract manufacturing from disk drive companies to produce its
products than by establishing its own manufacturing facilities. As a result of
the excess in manufacturing capacity in the disk drive industry today, the
contract manufacturing approach should result in lower short-term investment by
the Company, maximize the ability to vary production levels to meet demand and
lower the risk of early manufacturing start-up problems.
Additionally, chip manufacturers are readily available, and with the low cost
memory afforded using the UltraCard solution, low cost chips can be used while
still increasing the overall functionality of the card.
14
However, the Company does intend to maintain control over manufacturing from the
perspectives of manufacturing process and inventory exposure. The Company
intends to monitor the quality processes in the individual contract
manufacturers' plants including incoming inspection procedures, in-cycle quality
assurance and final burn-in and test. The Company also will establish ongoing
reliability inspection to ensure they meet specifications and reliability goals
before shipping to customers.
The commercial version of the read-write device design, 5 1/4" half-height,
(similar in size to a CD-ROM drive that can be inserted into the standard
computer tower, has been substantially completed during the quarter and the
pre-production soft tooled units for the initial pilot tests and demonstration
are expected to be completed by the Research and Development team at UltraCard
prior to the end of the fiscal year 2002. The Company is currently in
negotiations with a number of potential manufacturing partners to complete the
commercial version of the read-write device.
Another significant issue toward commercialization is that of the operating
system for the UltraCard technology. We believe that there are several systems
available with only slight modifications necessary. However, we believe that a
more attractive and longer-term option would be for the Company to develop its
own operating system. The advantage of developing its own system would be that
the Company would then enjoy proprietary rights over the initial and later
applications. This would result in licensing revenues being earned on a
continuing basis. The Company is exploring this possibility and has hired
consultants and contract employees for this purpose.
It cannot be stressed enough that an upward shift in the priority given by
Upgrade is to complete the commercialization process of its core, patented
technology as soon as possible. Through strategic partnerships and licensing of
its proprietary technology, the Company can plan its revenue stream. The
UltraCard technology product development strategy is guided by the tactic to
accumulate and retain ownership of as broad and comprehensive an intellectual
property package as possible in order to retain as much ownership of
intellectual property as possible.
It is planned that all research and development activities will be controlled in
house by the Company.
The previously announced pilot project in China is still in place, awaiting
delivery of our product. It is anticipated that delivery will take place within
six months after receipt of the capital necessary to complete commercialized
product. The receipt of sufficient capital is expected during the first quarter
of fiscal year 2003.
Additionally, the Company is in discussions regarding a significant
joint-venture opportunity in China which would involve significant distribution
of cards to support a number of applications.
Finally, the Company plans to fund cQue and Rockster to complete its software to
a commercialized state.
FINANCIAL RESULTS
Net losses aggregated $11.7 million in the three months ended June 30, 2002
compared with a $9.3 million net loss for the corresponding period of the prior
fiscal year. This increase in net loss is reflective of the increased cost of
capital incurred by the Company from financings through short-term loan
agreements. Interest costs of $5.3 million have been recorded in the current
quarter which is comprised, in the most part, of shares, warrants and notes
issued for interest and penalties on short term loans payable, compared to $2.7
million during the comparable quarter the previous year.
During the quarter, the Company wrote down its carrying amount of its sputtering
machine by $1.2 million, to record its new carrying amount at the estimated net
liquidiation value. The Company does believes that it will recognize the new
carrying amount upon Sale. However since the machine is designed specifically
for part of the manufacturing process of the UltraCard, this may not occur or
occur in a timely manner. The Company will continue to assess the carrying
amount of this asset. Further impairment write downs are possible in the future.
The Company's general and administrative costs of $3.7 million in the current
quarter represents a increase over the previous year, but consistent with the
previous quarter recognizing the Company's desire to curtailing certain
expenditures as a result of limited cash resourses. The Company is managing to
keep its expenses to a minimum during the tight cash flow periods. Expenses
relating to cQue were kept to a minimum reflecting the focus of the consolidated
group's efforts to complete the UltraCard technology. For the near future
research and development expenditures are expected to increase to meet the
Company's numerous potential market opportunities. All of the Company's research
and development costs have been expensed as incurred.
Sales and marketing expenditures of $77,000 represent a significant decrease
over the same quarter the prior fiscal year reflecting the Company's focus upon
product completion, and not necessarily of potential sales. Sales and marketing
expenditures typically are associated with the Company's attendance at trade
shows and industry awareness programs as the Company builds market awareness to
establish and develop new markets and prepare for effective product launches for
products which are nearing the first phase of completion.
The Company did record an allowance regarding the potential uncollectibility of
advances to The Pathways Group of $3.4 million during the quarter ended June 30,
2001.
For the first nine months of fiscal year 2002, net losses incurred were $32.4
million, of which $16.9 million of the nine month loss related to the costs of
capital, compared to $3.7 million during nine months ending June 30, 2001.
During fiscal 2002, the Company has found it difficult and expensive to raise
capital in the current capital markets. As a result, the Company has had to pay
higher costs to obtain operating capital, including the additional debt
financing costs including the issuance of its capital stock and warrants to
purchase stock. The cost is significantly higher than the Company would prefer;
and Management continues to spend a significant amount of time and resources
seeking other forms and lower cost capital to support operations. As of a result
of tighter cash flows, the Company's investment in research and development was
$3.4 million for the first nine months compared to $5.0 million the previous
years' comparable period. However, in spite of the tight cash position, this
does illustrates management's objective of moving the technology forward towards
commercialization. Other expenses have been kept to only those essential in
keeping the business operational with minimal discretionary expenses during this
tight cash flow period. General and administrative expenses were comparable to
the previous year period.
15
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2001 the Company had available cash balances of approximately
$329,000. The Company is managing very tight cash flows but still providing
funding for its research and development program at UltraCard. During the nine
months ended June 30, 2002, the Company raised approximately $3,600,000 in
smaller financings comprised of promissory notes with equity kickers (common
stock and warrants) and equity penalties (common stock and warrants) for failure
either to repay the notes or register shares owned by the noteholders. The
Company is not in default under these notes as long as it complies with the
equity penalty provisions. At June 30, 2002, the Company had total indebtedness
of approximately $3,500,000 under these arrangements.
Other funds were raised in the forms of convertible debentures from a related
party of the Company and short-term notes from existing shareholders. The
Company's cash used in operations was $ 5.8 million, which represents a $2.6
million decrease (31%) compared to the comparable period the prior year of $8.4
million. This decrease results from the increase in accounts payable and accrued
liability levels.
Cash flows from financing activities of $4.6 million in the nine month period
ended June 30, 2002 represents a level consistent with the last three quarters
of the year ended September 30, 2001. The Company has begun to focus it's
efforts upon financing initiatives which have a much larger magnitude than prior
financings and such initiatives have much longer lead times. While these
initiatives are in progress the Company is limiting the number of smaller more
expensive financings to critical needs. It is expected that upon receipt of
funding necessary to complete commercialization, the Company will make the
required investments either internally by way of capital expenditure and
personnel or by way of available outsourced resources to complete all required
tasks.
In order for the Company to meet the funding requirements of its investee
companies and to meet ongoing operating requirements, it will have to raise
additional financing. However the rate at which the Company expends its
resources is variable, may be accelerated, and will depend on many factors. The
Company will need to raise substantial additional capital to fund its operations
and may seek such additional funding through public or private equity or debt
financing, or through the licensing of its technology. There can be no assurance
that such additional funding will be available on acceptable terms, if at all.
The Company's continued existence as a going concern is ultimately dependent
upon its ability to secure additional funding for completing and marketing its
technology and the success of its future operations.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
-------------------------------
Upgrade, its president, Daniel S. Bland, and Chief Financial Officer, Howard
Jaffe, are defendants in The Pathways Group, Inc. v. Upgrade International
---------------------------------------------------
Corporation et al., Superior Court of the State of California in for the County
------------------
of Sonoma, c/a 227650. The complaint, filed August 3, 2001, alleges breach of
merger and collateral agreements between Upgrade and plaintiff, breach of oral
argument, fraud, and negligent material misrepresentation, and seeks specific
performance of the agreements, an injunction against exercising provisions
pursuant to the merger agreement whereby Upgrade could obtain control of
Pathways, and damages in excess of $150 million. Specifically, the complaint
alleges that Upgrade failed to provide interim financing to Pathways pending
consummation of the proposed merger transaction, and prevented Pathways from
obtaining alternate sources of financing. Upgrade believes that the plaintiff's
allegations are without legal or factual basis and therefore it has not accrued
any potential losses resulting from this claim except for the $3.4 million debt
owed by Pathways to Upgrade, which Upgrade has recorded a provision for
potentially uncollectible advances to Pathways as of June 30, 2001. The case is
currently in discovery.
Item 2. Changes in Securities and Use of Proceeds
------------------------------------------------------
During the three months ended June 30, 2002 the Company made the following sales
of unregistered securities;
In April 2002, the Company borrowed $575,000 from existing debt holders pursuant
to 30-day note agreements. Interest and penalties are required under the terms
of the notes payable every 30 days comprised of 10%-12.5% interest, 12.5% of the
original loan amount payable in common stock and up to 30% of the original loan
amount in warrants at an exercise price of the lowest average closing bid price
for a period 120 days prior to the date of the loan maturity but not more than
$0.25 to $0.80. In addition, as an inducement to enter into the financing the
Company issued 362,500 shares of common stock, and warrants entitling the holder
to purchase 362,500 shares of common stock at $.80 to $1.00 per share. The
warrants are exercisable immediately and expire five years from the date of
grant. As a finders fee on these agreements the Company issued notes in the
amount of $30,250, 80,094 shares and 193,532 warrants to acquire common stock at
an exercise price ranging from market to $0.80 per share.
16
In April 2002, the Company issued 55,000 shares pursuant to the terms of certain
loan extension inducement fees for March notes in the amount of $110,000.
On April 30, 2002 the Company received $290,823 pursuant to the terms of two
convertible debentures. The debentures bear interest at a rate of 10% per annum,
are immediately convertible into common stock at $0.75 per share, and mature on
December 31, 2002 In addition, the company issued 225,823 warrants to acquire
common stock of the Company at a price of $0.75 per share expiring five years
from the date of issuance.
In April 2002, the Company entered into a debt settlement agreement with a
creditor of UltraCard Inc. to settle $402,875 due to the creditor by the
issuance of four hundred thousand shares in the capital stock of the Company.
On April 5, 2002 the Company received proceeds of $100,000 pursuant to the terms
of a private placement of common stock of the Company at a price of $1.00 per
share. In conjunction with the offering the Company issued 100,000 warrants at
a strike price of $1.00. In addition to the warrants issued in conjunction with
the financing an additional 50,000 warrants were issued at a $1.00 strike price
and 230,000 warrants were issued at a strike price of $2.50 both for consulting
fees, paid to the investor. All warrants are exercisable immediately and have a
five year term from the date of issuance.
In April 2002 the Company issued warrants to acquire 1,730,000 shares in the
capital stock of the Company to a group of consultants in settlement of amounts
due those consultants. 1,250,000 of those warrants vest equally over a 12 month
period. The warrants have strike prices ranging from $1.00 to $2.50, are
exercisable immediately and have a five year term.
In May 2002, the Company borrowed $125,000 from existing debt holders pursuant
to 30-day note agreements. Interest and penalties are required under the terms
of the notes payable every 30 days comprised of 12.5% interest, 12.5% of the
original loan amount payable in common stock and up to 30% of the original loan
amount in warrants at an exercise price of market but not more than $0.25 per
share. As an inducement to enter into the loan agreement the Company issued
250,000 shares and 250,000 warrants to acquire shares of the Company at a price
of $0.75 per share. The warrants have a five year term. In addition, the
Company paid a financing fee comprised of a note payable in the amount of
$13,750, 110,000 shares in the capital stock of the Company and 275,000 warrants
to acquire common shares of the Company at a price of $0.25. The warrants are
exercisable immediately and expire five years from the date of grant.
On May 29, 2002, the Company entered into a release and settlement agreement
with CardTech, Inc., providing for the settlement of $650,000.00 due and owing
to CardTech by UltraCard. The amount of $650,000.00 was settled by the issuance
of 1,300,000 shares in the capital stock of Upgrade International Corp.
In June 2002, the Company received $90,000 from a group of private investors
pursuant to the terms of certain promissory notes agreements. The promissory
notes bear interest at the rate of 10%, regardless of the term of the note and
mature in 60 days from the date of issuance. The company also granted 180,000
warrants in aggregate to the note holders to acquire common stock of the Company
at a strike price of $0.25 per share. The warrants are exercisable immediately
and expire five years from the date of grant.
Additional warrant coverage is made available in the amount of 1,000 warrants
per day at a strike price of $0.25 per share, on two notes each in the amount of
$25,000 if the loans are unpaid by maturity.
In June 2002, the Company received from an individual private investor proceeds
of $250,000 pursuant to a promissory note agreement. The promissory notes bears
interest at the rate of 10% per annum and matures 60 days from the date of
issuance. In addition the company granted 50,000 shares of the capital stock of
the company and an additional 50,000 shares in the capital stock of UltraCard.
The company also granted 100,000 warrants with a strike price of $0.25 per share
with a five-year term.
During the quarter, the Company borrowed $37,500 from an officer of the Company,
which brought the total amount advanced by that officer to $775,000. On April
30, 2002 that balance was rolled into a convertible debenture, bearing interest
at a rate of 10% per annum and convertible into the common stock of the Company
at $0.75 per share. The convertible debenture has a maturity date of December
31, 2002. In addition, on April 30, 2002, the Company granted 1,200,000 warrants
issued as part of the debt transaction, to acquire common stock at a price of
$0.75 per share with a cashless exercise provision and a five-year term.
17
Item 5. Other Information
-------------------------------
In February 2002, the Company entered into a debt financing agreement with an
institutional syndicator to obtain up to $15 million in working capital for
Upgrade and its group of Companies. The debt instrument is for a seven-year term
with the principal due at maturity, and interest payable quarterly commencing in
year three of the financing. The loan is secured by the issuance of 40 million
shares of Company Stock, which will be issued under Rule 144A. These shares will
carry a different CUSIP number from the Company's Common Stock. Additionally, 5
million restricted shares under Rule 506D were also deposited into the custody
account. All shares are restricted , and can only be traded among qualified
institutional investors. Upon repayment of the credit facility, the shares are
to be returned to the Company. Contained in the agreement is the stipulation
that the voting rights of the 45 million shares by way of proxy will be voted in
proportion with the existing shareholder base. This transaction has not as yet
funded. The Company has cancelled this transaction and have requested the return
of its shares which were to collateralize the financing.
During the quarter, citing various conflicting business issues and other
commitments, C. Rowland Hanson resigned as a director of the Company. The
Company plans to continue its relationship with Mr. Hanson's consulting company
regarding communication and branding strategies.
Item 6. Exhibits
--------------------
Exhibit No. Description
99.1 Certification of the Chief Executive Officer of the Registrant,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of the Chief Financial Officer of the Registrant,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
18
SIGNATURES
----------
Upgrade International Corporation
/s/ Daniel S. Bland
Date: August 19, 2002 -----------------------------------------
Daniel S. Bland, President and Chief
Executive Officer, and Secretary
/s/ Howard A. Jaffe
Date: August 19, 2002 -----------------------------------------
Howard A. Jaffe, Executive Vice President
Chief Operating and Financial Officer
19